Monday, January 21, 2013

Real Goods Solar ( Nasdaq - RSOL ) -- Speculative Turnaround

Real Goods Solar (RSOL $0.85) appears on track to report unexceptional Q4 results.  New management was brought in during the third quarter.  The company's two largest shareholders each contributed $1.0 million in debt financing, as well, to tide things over while operations were straightened out.  Overdue receivables were collected, reinforcing cash flow.  Middle management was streamlined.  New marketing techniques have been developed.  And better supply arrangements were negotiated.  Still, the overhang from earlier mistakes almost certainly kept sales below potential.  Margins probably remained below normal, as well.  Another sizable loss is anticipated.

The solar installation industry is thriving, though.  If Real Goods Solar's new management team can restore operations to normal, profitability could reverse course in a meaningful way.  The company is a leading provider of solar systems for residential (50% of sales) and commercial (50%) customers.  The latter business was added early in 2012 via an acquisition.  The underlying business remains solid but too much bureaucracy was created by the merger.  Most residential contracts provide homeowners with electricity at prices below local utility costs with no upfront investment.  Real Goods Solar engineers and builds the systems, and then sells them to investors who benefit from a raft of tax benefits.  Homeowners either lease the systems and pay a fixed monthly amount.  Or they pay for the electricity they use, subject to a monthly minimum.  The format usually depends on what kind of buy-and-sell deals are available with the local utility.

U.S. tax credits offset 30% of a system's cost.  The law actually allows higher credits based on a "market value" formula, although that approach has been subject to abuse and now is being investigated by the government to identify possible fraud.  State and local governments provide additional payments.  And many utilities are forced to offer incentives of their own.  On top of that the I.R.S. permits 60% first year depreciation, and 100% after five years.  Low interest rates facilitate financing options further.  As a result installation companies like Real Goods Solar can sell systems at a hefty mark-up to the financing companies. The trick is to keep marketing, management, and regulatory costs to a minimum.

A large debt payment comes due next April.  Sales expansion is likely to be held back until that obligation is refinanced.  The bank is sure to require evidence that margins are returning to normal.  Despite that constraint on selling expense, sales promise to improve at an above average rate.  Panel costs continue to fall.  Installation methods have become increasingly efficient.  And the tax incentives will remain in place until 2016, if they aren't extended.  Climate change has been identified as a top priority by President Obama as he begins his second term.  Additional boosts could emerge.

We estimate Real Goods Solar will return to profitability this year.  In 2-3 years sales could reach $150-$200 million.  At 5% pretax margins fully taxed income could attain $.15-$.20 a share.  Higher margins appear possible, especially if the regulatory climate is simplified.  Obtaining permits and hook-ups now accounts for 25%-40% of a deal's total cost.  Aligning local utility interests with the solar industry could yield further benefits.  New solar technologies are in the pipeline which could double price performance of the panels themselves in 2-3 years.  That rate of improvement could be sustained for several iterations, making solar a mainstream technology.

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